Merck: Now A Compelling 'Buy' Candidate

| About: Merck & (MRK)

The pharmaceutical industry is an interesting sector to invest in. This sector has seen tremendous stability courtesy of the nature of its business in keeping us healthy even during recession, and has been generating an enormous amount of wealth over the years. Though there are apparent risks like government price controls, health insurance dependency, pipeline risks, stiff competition and litigation, the sector has always managed to maintain its profitability and continues to grow at a frantic pace.

Merck (MRK) is a global healthcare company, delivering health solutions. It is one of the largest companies in the U.S. as far as its market capitalization goes, standing at about $115 billion and has its presence in four segments namely, Pharmaceutical, Animal Health, Consumer Care and Alliances. The company generates annual revenue of about $48 billion and has an extremely high operating margin of about 22% against an industry average of $5 billion and 12% respectively. These statistics make the company a frontrunner in its business and an extremely lucrative option for investors.

In May 2011, the company acquired Inspire Pharmaceuticals, a company that has been growing at about 15% per annum, to expand its business in ophthalmology and added about $110 million to its revenue per year. It also sold its 50% interest in Johnson & Johnson (NYSE:JNJ) in September 2011for an amount of $175 million with the intention of expanding its business directly in the OTC category of drugs, without any restraints from its joint venture partner. In December 2011, it further opened an Asia Research & Development (R&D) headquarters at Beijing, China to take advantage of rapidly growing Asian economies. This will not only enable the company to enter a large, concentrated and needy market but also reduce its costs in research and development owing to the availability of cheap labor and growing professionals. All these recent strides have enabled the company to position itself for a giant leap in business and profitability.

Its stock has an extremely low beta of 0.36, making it a highly consistent investment portal in the otherwise volatile environment. The company has an EPS of $2.02, and a relatively high P/E at current valuations levels, at 18.69, due to the stock's recent climb, against an industry average of $2.02 and 15.36 respectively. In addition, the company has also been rewarding its stock holders with a regular share of its profit through a generous dividend over the years, and has a current dividend yield of about 4.40%. It has also shown a rapid acceleration in its earnings growth for the past three years, which is an extremely positive development.

One major competitor of Merck that has similar revenue earnings is Bayer AG (OTCPK:BAYRY). This company resembles Merck in its revenue generation and P/E but has a slightly higher EPS at $3.96. However, its operating margin of 12.65% is lower than that of Merck's 22%. The company has also provided a very cautious guidance for the forthcoming year while declaring its financial results for 2011. The company has very few new products on offer currently and the fate of about 40 products in clinical stages is uncertain. Keeping all these factors in mind, in my opinion the company is at a higher risk than Merck wherein, a fall in sales or a failure in launching of a new product will have a major impact by way of resultant loss or erasure of profit.

We can also compare Merck with GlaxoSmithKline (GSK). This is a larger company by way of its market capitalization of $225 billion and employs almost one hundred thousand people. It has however been witnessing declining revenue at $43.52 billion as per last year's figures. The company also faces numerous lawsuits for its diabetes drug "Avandia," a drug that is reported to be causing an increase in cardiovascular failures. Though, the company has shown a decent net income of $8.36 billion, exceeding that of the analysts' estimates, the market risks that it faces has not been factored in the prices of its shares. It is trading at a far higher valuation and is not recommended for investments at current levels. However, those who like to see some safety in their investments can consider buying GSK at lower levels especially since the company operates at profit margins exceeding 30% and has few products like a drug for rare sarcoma cancer in its final stages of FDA approval.

Pfizer (PFE) is another mammoth in this industry having a market capitalization of about $170.5 billion and employee strength of about 103700. The company generates massive revenue of $67.4 billion with an operating profit of about 29%. However "Lipitor," one of the drugs produced by the company that's generating about 14% of the company's revenue, has recently come off the patent, which can make a substantial dent on its profit. This company is also facing recent setbacks in a few of its products like Champix, Eliquis, Lipitor lawsuits, Dimebon, etc., which has put the company in a higher-risk category. However, it is currently in the process of selling off its non-core businesses and may restructure itself into two divisions, which may result in the unlocking of its value. However, in my opinion, the stock is currently trading at very high valuations and investors should only invest in this counter during corrections of its price to about $18 to $20 in order to benefit long term.

Given the stability of the sector as a whole, Merck provides an excellent platform for investors with low-risk profiles. However, the company, like all drug manufacturers, does face an inherent risk in its business from research and development works, government regulations and litigation. In a recent case of its R&D efforts, Merck had a setback when its therapy for "sarcomas" was not approved by the FDA. Another one of its drugs used for treatment of cancer "ridaforolimus" is under scrutiny and its approval by many is considered to be under the clouds. At the same time, the company is pinning its hopes on a Cholesterol control drug, which is under active consideration for approval by the FDA. However, due to the company's sound financials, it is unlikely that adverse news on these new drugs is going to affect its overall profitability greatly.

Hence, keeping all the above factors in mind, I feel that the company is a great buy not only due to its sound financials but also due to its presence in a business sector that can hardly be affected by a global slowdown. It has established itself as a premium brand in the healthcare sector through its performance over a hundred years since its foundation in 1891. The company has an access to both the developed and the developing economies from where the future generation of revenue should be profitable.

Further, it is likely to grow rapidly in the years to come due its large investment in research and development, especially to cater to the requirements of emerging markets. I strongly recommend buying this stock to investors seeking appreciation of their wealth that have a low-risk appetite. This is attributed to its strong fundamentals, along with the imminent growth of the sector in the face of emerging world economies that are willing to allocate substantial funds toward improving the healthcare of their ever increasing population.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.